From: Jane Fahey [jcfahey@earthlink.net]
Sent: Monday, May 10, 2004 4:49 PM
To: rule-comments@sec.gov
Subject: 2% redemption fee File No. S7-11-04
To the SEC, Please read the following:
REVIEW & OUTLOOK (Editorial)
Headline Risk at the SEC
738 words
10 May 2004
The Wall Street Journal
A16
English
(Copyright (c) 2004, Dow Jon es & Company, Inc.)
Generally speaking, the mutual-fund industry is a great model of market
capitalism. It is big, diverse and madly competitive. And if our say-so
doesn't convince, then the fact that customers are happy to entrust several
trillion dollars to mutual funds should suffice. So, why has the Securities
and Exchange Commission embarked on a frenzy of rule-making directed at a wide
range of industry workings?
The polite answer is that the SEC is overreacting to the scandal that surfaced
nine months ago. That's when some funds were caught allowing large investors
to engage in two dubious trading ploys: late trading and market timing. Late
trading is the clearly illegal practice of placing orders after the day's
close at 4 p.m., and market timing is the disru ptive (but not illegal)
practice of trading quickly in-and-out of a fund.
Both practices take advantage of the fact that funds do not price their
securities on a continuous basis, but only once a day. This causes prices to
be "stale" and open to gaming. Stale-price trading by some investors
disadvantages all other investors.
But once the news of these trading practice was known, the market extracted
its own punishment: Investors pulled tens of billions of dollars out of the
guilty funds. Dozens of senior executives were fired. And, under existing law,
the funds were required to ante-up large fines.
Meanwhile, back at the SEC, the regulatory blunderbuss was firing at full
bore. The commission generated about 10 proposals for a myriad of new rules
aimed at everything from disclosure to corporate governance. Most of these
rules will hurt investors without adding anything to the party.
Take the rule to impose a 2% redemption fee on investors who redeem their
shares within five days of purchase. This rule is meant to stop trading on
stale prices. But academic studies have shown that it will, at best, only
discourage such trading, not end it, since stale-price trading would still be
profitable after big market moves even after netting out the penalty fee.
Worse, this fee would whammy innocent investors who have unexpected liquidity
needs or even experience a change of mind.
Ditto for the proposal to require a hard 4 p.m. close on orders. The current
rule allows intermediaries -- such as broker-dealers, banks and retirement
funds -- to aggregate orders from customers across the day and submit them
after 4 p.m. The orders are time-stamped so that those received after 4 p.m.
are not supposed to trade at that day's price. If these intermediaries now
have to submit orders before 4 p.m., investors will have to make decisions
early in the day -- before the events of a complete trading day can be known.
The really grating aspect of the SEC's extravaganza of rule-making is that
there is a simple, non-harmful remedy for stale-price trading -- fair-value
pricing. This technique requires funds to adjust stale prices to values that
they would obtain if trading were continuous.
Even better, the remedy is already in place. The SEC mandated fair-value
pricing in 2000 and 2001. Pretty much nobody paid attention and the SEC itself
let the matter languish. Then, last December and again in April, two of the
SEC rule-making proposals adopted on compliance and disclosure referenced the
fair-value pricing requirement, underlining that mandate.
Recently, the SEC has made noises about taking disciplinary action against
funds that failed to use fair-value pricing. Although the names of the funds
have not been made public, the betting is that the targets come from the
commission's survey, done in September, which found nearly a third of 960
funds had not used fair-value pricing in the previous 20 months.
Enforcement of a law already on the books is all that is necessary. It is
regulatory overkill for the SEC to dictate the make-up of boards of directors,
require a code of ethics or the disclosure of portfolio managers'
compensation.
So, back to our question of why the SEC is proposing all these regulations,
let us give the less polite answer: It has great headline value. The problem
is that, after the headlines have faded, these regulations will raise costs,
limit choices and diminish liquidity for the 95 million investors who invest
in mutual funds.
Jane C. Fahey
Fahey Financial, Inc.
1500 Abbott Road, Suite 130
East Lansing, MI 48823
(517) 336-7225 office
Securities offered through Royal Alliance Associates, Inc., Member NASD & SIPC